Financial Crisis

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Originally Posted by cheifo

BTW Stuttgart I saw that documentrary series presented by Niall Ferguson.
I felt after watching it, that his conclusions centred around tribalism and how we have to learn how it dangerously rears its head in uncertain times.

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Yep, it was hard to argue with his findings. It was a very good series.

The root of the financial crisis in my humble opinion was that money became increasingly cheap and increasingly hard to lose, mainly due to the Fed looking to prop up asset values at every hint of trouble. When something becomes cheap people lose respect for it: banks lent it too carelessly and borrowers borrowed it too carelessly.

I'm not convinced that the individual bankers themselves are too blame. I work in the industry and have seen the sheer greed and lack of humility of several involved but for every such wnaker I've come across dozens just doing a job because it's a decent career and it's the natural thing to do if you have some sort of a business or financial training.

Like in sport or any walk of life the rules were there to be gamed. I'm sure playing the offside trap was never in the rulemakers' minds when they drew up the rule to prevent goalhanging. I'm sure we all speed up between motorway speed cameras before seeing one and slowing down for a bit and then speeding up again.

Companies in the non-financial sector game the accounting rules. I'm not talking about Enron or Worldcom-like cheating, I'm talking about playing right on the edge of the rules. Bankers did this with the regulatory capital rules. You'd be disappointed with them for not doing so - both from a "cleverness" perspective and also as a shareholder (not in hindsight maybe :)). However, you have to be just as disappointed with the regulators for allowing both the sheer scale of regulatory gaming that went on, as well as the really simple stuff: the outright fraudulent and in my opinion criminal lending practices at grass root level.

In the south east UK this weekend the weather was simply amazing. Shorts and T-shirt weather and it was mid-October. The thought struck me: if bankers were weathermen they would have allocated no probability of such weather in October and would have bet ridiculously large sums against such a probability. The rating agencies would have gone out to the garden, taken the temperature and declared with AAA certainty that it was summer, and walked away with USD 300k from everyone that asked. Those that asked would have taken their word for it and have to throw away their lilo's on Monday when the clouds returned, wondering why on earth they wasted money their money on something with such little use.

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Originally Posted by Stuttgart88

1) banks lent it too carelessly and borrowers borrowed it too carelessly.
2)
I'm not convinced that the individual bankers themselves are too blame. I work in the industry and have seen the sheer greed and lack of humility of several involved but for every such wnaker I've come across dozens just doing a job because it's a decent career and it's the natural thing to do if you have some sort of a business or financial training.

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These two points are always forgotton by people when they are going off on one against the banks.

Don't think anyone blames ordinary staff of banks. most anger/vitriol I hear/read is aimed at top brass (i.e. policy makers)

Have been thinking about this a lot over the last week.

What happened was absolutely unavoidable in the absence of stronger government regulation. That isn't a banker simply pushing the blame around, its reality. Here's why.

Imagine we had a bank, lets call it Bank of Responsibility (BoRe ;) ). Say 2-3 years ago, BoRe had a "road to Damascus" moment and decided that property prices were unsustainable, its loan to deposit ratio was too high and generally it needed to act more conservatively. It therefore decided it would buck the trends of its peers and would not offer high LTV mortgages or speculative property development financing.

In a very short amount of time BoRe's share price would have been savaged by the market, thats right, the same "market" thats now complaining to high heavens about the behaviour of the banks. In short order it would've been taken over by another bank and its management replaced. This isn't a guess or a leap of faith, there are plenty of examples in the last 10 years of conservative banks whose share price got hammered and were taken over by more "enlightened" competitors.

So, we have identified that the system was broken and all the lemmings were running to the edge of the cliff. Who was responsible for stopping them?

If you are a true libertarian or free marketeer, the answer is no-one. We will only learn that its stupid to jump off the cliff after we see all the lemmings die doing it.

If you believe in having a framework of rules and regulations to save society from itself, then Government failed. And thats Government in its widest sense including, but not limited to, IMF, G7, BIS, EU, CEBS......

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Originally Posted by OneRedArmy

Have been thinking about this a lot over the last week.

What happened was absolutely unavoidable in the absence of stronger government regulation. That isn't a banker simply pushing the blame around, its reality. Here's why.

Imagine we had a bank, lets call it Bank of Responsibility (BoRe ;) ). Say 2-3 years ago, BoRe had a "road to Damascus" moment and decided that property prices were unsustainable, its loan to deposit ratio was too high and generally it needed to act more conservatively. It therefore decided it would buck the trends of its peers and would not offer high LTV mortgages or speculative property development financing.

In a very short amount of time BoRe's share price would have been savaged by the market, thats right, the same "market" thats now complaining to high heavens about the behaviour of the banks. In short order it would've been taken over by another bank and its management replaced. This isn't a guess or a leap of faith, there are plenty of examples in the last 10 years of conservative banks whose share price got hammered and were taken over by more "enlightened" competitors.

So, we have identified that the system was broken and all the lemmings were running to the edge of the cliff. Who was responsible for stopping them?

If you are a true libertarian or free marketeer, the answer is no-one. We will only learn that its stupid to jump off the cliff after we see all the lemmings die doing it.

If you believe in having a framework of rules and regulations to save society from itself, then Government failed. And thats Government in its widest sense including, but not limited to, IMF, G7, BIS, EU, CEBS......

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I must say that is a well written, easy to follow and illustrative post!!:)
If only we could swap lemmings for some of the fat-cat bankers!

p.s. I would like to open an account at BoRe, and also arrange a mortgage!;)

Very good ORA.
And understanding that would make you pessimistic that present plans for shoring up International Banking, as it currently operates, is doomed.
The bailouts are support props for a crumbling ediface.

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Like in sport or any walk of life the rules were there to be gamed. I'm sure playing the offside trap was never in the rulemakers' minds when they drew up the rule to prevent goalhanging. I'm sure we all speed up between motorway speed cameras before seeing one and slowing down for a bit and then speeding up again.

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Stutts,I think it's the absence of rules thats a big part of the problem. To use your traffic analogy, 99% of people can accept the need for traffic regulations, without such regulations would be a recipe for chaos but with such regulations the traffic code structure can cope with the impulsive code breaker.

ORA, 9 years ago Washington Mutual's share price was attached because they decided to reduce exposure to US mortgage-backed bonds!

Edit:

From the FT's Long View in September:

WaMu on Friday became the biggest bank failure in US history (a title it will hopefully keep for a while). Its decline, as has been amply documented, lay in its huge portfolio of mortgages and mortgage-backed bonds.

A decade ago, assumptions were different. The last WaMu story I wrote covered a day when its share price fell 5 per cent in June 1999. It fell because investors were worried that it was retreating from its policy of levering up by buying mortgage-backed securities.

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Originally Posted by geysir

Stutts,I think it's the absence of rules thats a big part of the problem. To use your traffic analogy, 99% of people can accept the need for traffic regulations, without such regulations would be a recipe for chaos but with such regulations the traffic code structure can cope with the impulsive code breaker.

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The absence of rules - or the inability to apply them - in the "shadow banking sector" allowed a massive amount of leverage to be built up. I heard last week that the so-called shadow banking sector at its peak actually exceeded the actual banking sector by assets though I'm not sure this is true.

However, within the actual banking sector i.e., the global regulated banking system, it can't really be argued that the rules weren't there. They were gamed to the nth degree and in hindsight they were poor rules. Here's an example: take a standby commitment from a bank to its customers (i.e., they don't actually lend money on day 1, they merely say if you need the money at some point in the future we'll give it to you. An overdraft for all intents and purposes). The regulatory rules say that if the commitment period is less than a year then that commitment warrants zero capital otherwise it's a full capital charge in line with the type of borrower it is. If the commitment is drawn upon then the resulting loan attracts a capital allocation in line with the type of borrower it is.

So: if the commitment is for 364 days it's zero capital and if it's 365 days it's full capital. Does 1 day make that much economic difference? The banking system subsequently set up vehicles with hundreds of billions of such liquidity commitments for 364 days (zero capital). They bought long term AAA securities in these vehicles and these vehicles issued short term debt in the US money markets and month after month, year after year this debt was simply rolled over. The banks just kept amending the maturity date of the commitment perios, but always within 364 days.

The result: the banking system effectively owned hundreds of billions of risk with no capital supporting it. At one point in time it didn't even have to report the existence of these hidden assets or contingent liabilities.

A German bank with a substantial Dublin operation failed last year because the size of its off balance sheet asset book, and corresponding commitment to finance the vehicle holding these assets if for whatever reason the US money markets stopped wanting to roll over its short term debt. I can't recall the exact numbers but this bank made liquidity commitments multiple times the maximum amount it could ever realistically expect to have available in cash or liquid assets. How the rating agencies allowed this to happen is beyond me. How the regulators allowed this to happen is beyond me. How management allowed it to happen is beyond me.

These vehicles were an early part of this "shadow banking system" and what happened in Q3 last year was a run on these vehicles, no different to a run on conventional banks.

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Originally Posted by pete

Given this is a Current Affairs forum can we stick to some level of facts instead of wild speculation?

Will be interesting to what level of interest rate cuts are passed on if any & which banks act.

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Given this is a Current Affairs forum can we stick to some level of facts rather than wildly spectlating what level of interest rate cuts are passed on if any & which banks act? :)

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Originally Posted by Stuttgart88

The absence of rules - or the inability to apply them - in the "shadow banking sector" allowed a massive amount of leverage to be built up. I heard last week that the so-called shadow banking sector at its peak actually exceeded the actual banking sector by assets though I'm not sure this is true.

However, within the actual banking sector i.e., the global regulated banking system, it can't really be argued that the rules weren't there. They were gamed to the nth degree and in hindsight they were poor rules.

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I understand that rules are there. I am more referring to the bigger picture of tried and trusted regulations which were wound down to allow deregulation (in the UK called Better Regulation Task/Commission :rolleyes:)
An environment for all sorts of skullduggery.
Eg. the minimum cash reserve that a UK bank was reduced from 20.5% in 1968 down to 3.1% in 1998, at present it is a voluntary%.

The situation in Iceland has got infinitely more serious.
The Banking law requires that saving deposits are first taken care off when a Bank collapses.
The Brits were ready with pen in hand to sign an agreement that Icesave assets (Landsbanki UK) be sold in order to cover the savers deposits. The assets would cover the Icesave deposits, easy enough to a £30k limit for each saver account. Then the Brits backed off at the 12th hour and want the Landsbanki assets to be used to pay other debts in the UK.
No mention yet what these other debts are. I'm suspicious.
The Icelandic PM refused to agree. The IMF & Russians won't loan until there is an agreement. The Brits know that.

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Originally Posted by geysir

Eg. the minimum cash reserve that a UK bank was reduced from 20.5% in 1968 down to 3.1% in 1998, at present it is a voluntary%.

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Are you sure?

AFAIK its broadly 8% of risk weight assets (loans) in capital (cash and cash equivalents [liquid securities]). So depends hugely on the riskiness and composition of the individual bank's loan book.

And thats an EU Directive, not an FSA-specific regulation.

As an aside, if Ireland hadn't joined the Euro (if me granny... etc.), we'd be Iceland Mark II. Thankful for small mercies etc...

I got to
/Reserve requirement

from this
Fractional reserve banking
I was trying to understand the hows and the whys a Central bank prints more money.

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Originally Posted by geysir

I got to
/Reserve requirement

from this
Fractional reserve banking
I was trying to understand the hows and the whys a Central bank prints more money.

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http://ec.europa.eu/internal_market/...l/index_en.htm

This is what governs how much capital European banks hold. Look for the Capital Requirements Directive.

The relationship to the amount of printed money is circulation is as remote as to be irrelevant IMHO.

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Originally Posted by OneRedArmy

As an aside, if Ireland hadn't joined the Euro (if me granny... etc.), we'd be Iceland Mark II. Thankful for small mercies etc...

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I presume by this you mean the punt would be monopoly money?

I think I heard that Icelandic currency is worthless outside the country which is making it difficult to import any goods including food. I guess everyone is on a fish only diet...

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Originally Posted by pete

I presume by this you mean the punt would be monopoly money?

I think I heard that Icelandic currency is worthless outside the country which is making it difficult to import any goods including food. I guess everyone is on a fish only diet...

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Yeah, punt would be worthless as it would've been hugely devalued.

A quick look at individual and macro leverage (indebtedness/loans to deposits) measures show us as being next worst to the Icelandics, with the Brits also up there as well.

I think the Danes had an even bigger real estate bubble than we had & some of their banks have Baltic and other EM exposures.

My dad has some money on deposit with National Irish which is protected under the Danish scheme, not the Irish one, beacuse they're owned by Danske Bank. I'm going to tell him to move it. The Kroner is getting hit and today they've put rates UP in Denmark to try and protect the currency.

Total capitulation again in the markets today. Rumours that GM will file for Ch11 today. Currencies are all over the place. Credit markets getting hammered. The great deleveraging (i.e., selling of assets financed by debt because the lenders want their money back) is gathering pace. There will be massive hedge fund casualties.

Credit getting hit particularly hard. This really could be a vicious death spiral: fundamentally solid and cash generative companies may go to the wall because their banks won't refinance their loans and the bond markets are closed. Bankruptcies and credit downgrades will therefore gather pace. This'll make banks even less likely to lend and so on.

There were many bad stats out this morning but this one stood out for me: Vovlo sold 41,000 trucks in Q3 2007. In Q3 2008 they sold 115!

The 30 year swap is trading through US treasuries - ok, this is a technical thing - but though it can be explained it was previously thought not just highly unlikely but "impossible"!

Nouriel Roubini's speech in London yesterday is worth watching. The gloomy war prophecies we touched on here 2 weeks ago were even mentioned!

http://www.rgemonitor.com/blog/roubi...arket_shutdown

The world economy is getting worse by the day now. Don't know where it is but the sooner we hit the bottom the better as can't plan recovery until we get there.

It seems one the problems with coming off property bubble into recession is that won't be another property bubble to back the boom days. I wonder what the next bubble will be caused by. We have just had IT & Building. Maybe renewable energies?

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Originally Posted by OneRedArmy

http://ec.europa.eu/internal_market/...l/index_en.htm

This is what governs how much capital European banks hold. Look for the Capital Requirements Directive.

The relationship to the amount of printed money is circulation is as remote as to be irrelevant IMHO.

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I was only giving an example of one regulation that was changed, re cash reserves.
You asked was I sure.
I pointed out the link to you.
No one ever says thanks :)

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Originally Posted by pete

The world economy is getting worse by the day now. Don't know where it is but the sooner we hit the bottom the better as can't plan recovery until we get there.

It seems one the problems with coming off property bubble into recession is that won't be another property bubble to back the boom days. I wonder what the next bubble will be caused by. We have just had IT & Building. Maybe renewable energies?

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Premiership football?
What happens if BSKY or Setanta can't refinance their debt, or the football clubs themselves?

Why would Renewable energies be regarded as a bubble to burst?
Is it subsidised to make the Kw price competitive?

On the surface it ticks some important boxes, it is local based, creates labour, less imports.

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Originally Posted by geysir

Why would Renewable energies be regarded as a bubble to burst?
Is it subsidised to make the Kw price competitive?

On the surface it ticks some important boxes, it is local based, creates labour, less imports.

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I think Pete is suggesting that renewable energy might be the next big boom industry. Which we'll then allow our economy to become massively over dependent on and when energy markets suffer a decline the country will go into meltdown, perpetuating the cycle.

I see.
Still, investing in something that reaps benefit on so many hard core aspects is a solid enough investment also that type of investment is spread out over different types of renewable energy, diversifying dependance.

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Originally Posted by Stuttgart88

Premiership football?
What happens if BSKY or Setanta can't refinance their debt, or the football clubs themselves?

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Similar to the ITV Digital collapse, I suppose. Clubs going into adminstration all over the place, but ultimately surviving, albeit much cut back.

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Originally Posted by passinginterest

I think Pete is suggesting that renewable energy might be the next big boom industry.

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Yes. It might be a bubble but need something new to drag out of the slump.

Ireland is almost completely dependent on foreign multinationals with no significant local employers exporting products/services.

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Originally Posted by geysir

I was only giving an example of one regulation that was changed, re cash reserves.
You asked was I sure.
I pointed out the link to you.
No one ever says thanks :)

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Thanks for quoting the link, but it was wikipedia and wasn't particularly accurate and thats being kind :p

I see Stuttgart is calling capitulation, the problem is that you only know the bottom after the fact.

I've incorrectly called it twice so far!!!

The non-financial treasury market is very worrying (ABCP etc.). Banks need to be forced to lend to "real economy" companies as part of Government bailouts.

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Originally Posted by OneRedArmy

Thanks for quoting the link, but it was wikipedia and wasn't particularly accurate and thats being kind :p

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AFAICS the Wiki reference to reserve requirement was accurate.
The statistics to the cash reserves requirement was quoted from the IMF figures.
The explanations on the Wiki may not be so accurate but I am not referring to those explanations.

AFAIU a bank's Cash Reserves is a ratio of cash held in reserve to deposits.
Bank hold in reserve a certain % of its liabilities (savers deposits)
It is the 3rd tool of monetary policy.
Imposed Cash Reserve requirements has the effect of putting a ceiling on Bank lending thus putting a ceiling on Bank's exposure to loans it gives out.
I would question when you say that the reduction in cash reserve requirements over the last 35 years for Banks is irrelevant.

The day after stonewalling the Brits attempts to hold every Icelander, man woman and child, bondage to a personal debt of approx £30k each and all that on top of insults and previous grevious injuries already inflicted, the Ice Gov signed a deal with the IMF for a loan of US$2bn.
I don't know what the terms are but the IMF guy sounds very positive about the 'bouncebackability' of Iceland :)
By my reckoning, that's a couple of months supply of heroin and B&B paid for.
There is some benefit to being first in the queue.
Apparantly for some reasons yet unknown, the survival of this Island is important for the survival of Western civilization.
Meantime, while we are on our mainline drip, we can listen to the long drawn out death rattle of the Celtic Tiger.

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Originally Posted by OneRedArmy

if Ireland hadn't joined the Euro (if me granny... etc.), we'd be Iceland Mark II. Thankful for small mercies etc...

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That I find strange as the Brits never joined the Euro either. :confused: And I want them to join it.

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Originally Posted by geysir

AFAICS the Wiki reference to reserve requirement was accurate.
The statistics to the cash reserves requirement was quoted from the IMF figures.
The explanations on the Wiki may not be so accurate but I am not referring to those explanations.

AFAIU a bank's Cash Reserves is a ratio of cash held in reserve to deposits.
Bank hold in reserve a certain % of its liabilities (savers deposits)
It is the 3rd tool of monetary policy.
Imposed Cash Reserve requirements has the effect of putting a ceiling on Bank lending thus putting a ceiling on Bank's exposure to loans it gives out.
I would question when you say that the reduction in cash reserve requirements over the last 35 years for Banks is irrelevant.

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Thats not correct, at least in the EU. Liquidity is pretty much self-managed. Loan to deposit ratios vary hugely. From around 100% for the more conservative savings banks to 280% for PTSB (Northern Rock was similarly high). Banks have been free to decide how much they leverage their book with market funding, within the constraints of the capital adequacy legislation I linked above.

I looked over that link but (my fault) I can't find a good table/graph/summary which sets out the minimum Capital Requirements (as in Bank cash or assets that can be quickly liquidised).
But I do find that the Directives are blessed by Charlie McC. (sirens, alarms bells).
"A key aspect of the new framework is its flexibility. This provides institutions with the opportunity to adopt the approaches most appropriate to their situation and to the sophistication of their risk management."
That reads to me, as let the Investment/Lending Institutions work out what's best for themselves.

In general that system works until debtors forfeit their mortgages because the mortgage payments far exceed the value of the house for which they took the loan or/and their ability to repay is reduced. And this works okay until people lose confidence in their bank and want to withdraw their money or at least reduce their deposit.
At that stage you get a run on the bank, which - under such circumstances (the current circumstances) - is greatly undercapitalized. Two things can happen then. Either the bank collapses or someone (like the government) steps in to prop up the bank. But if the government does that - and the government itself is already in debt - then confidence might not be very high in this solution, especially when middle- and lower-income taxpayers realize that they are the ones who ultimately end up footing a bill that is likely (as past and present history shows) to only put more money in the pockets of rich and greedy investment institutions.

On another point, MMR?, what has the BOE done here in plain English?
from the BOE annual report 2007 page 36.
Banking Department balance sheet
'The principal reason for the increase in the Banking
Department balance sheet, £39.4 billion at 28 February
2007 (2005/06: £24.8 billion), was the introduction of
Money Market Reform (MMR) in May 2006. The new
framework is based on a reserves-averaging system, with
reserves-scheme participants electing to maintain a target
balance on average over a maintenance period running
from one MPC meeting to the next. These balances are
reflected in ‘deposits from banks and building societies’ on
the Banking Department balance sheet and have been
matched by an increase in the Bank’s lending via
short-term open market operations (OMOs), ‘loans and
advances to banks’. At 28 February 2007, around
£20.3 billion of Banking Department’s assets comprised
sterling money market refinancing provided through the
Bank’s OMOs (2005/06: £3.2 billion). The size of the Issue
Department’s deposit with Banking Department has
remained close to £50 million'.

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Originally Posted by geysir

I looked over that link but (my fault) I can't find a good table/graph/summary which sets out the minimum Capital Requirements (as in Bank cash or assets that can be quickly liquidised).].

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There isn't a good summary as its complicated. Very, very complicated. Broadly for large banks its internally driven by credit models which predict the probability of default, loss given default and exposure at default. See below.

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Originally Posted by geysir

But I do find that the Directives are blessed by Charlie McC. (sirens, alarms bells).
"A key aspect of the new framework is its flexibility. This provides institutions with the opportunity to adopt the approaches most appropriate to their situation and to the sophistication of their risk management."
That reads to me, as let the Investment/Lending Institutions work out what's best for themselves.

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Broadly correct. They earn the right to self-determine their own regulatory capital based on a long and rigorous approval process by regulators which is subject to ongoing review. They are various floors, limits and other checks that ensure that capital is adequate.

These changes (known as Basel II) are only in the process of coming into force and are only bedding in so this crisis was too early to test them.

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Originally Posted by geysir

In general that system works until debtors forfeit their mortgages because the mortgage payments far exceed the value of the house for which they took the loan or/and their ability to repay is reduced.

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Not exactly, you use models to predict this and the problems occur when the models don't correctly predict the number and magnitude of defaults.

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Originally Posted by geysir

And this works okay until people lose confidence in their bank and want to withdraw their money or at least reduce their deposit. .

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Whoa, this is now liquidity risk, not credit risk, which is what you were discussing above.

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Originally Posted by geysir

At that stage you get a run on the bank, which - under such circumstances (the current circumstances) - is greatly undercapitalized. .

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No, does not follow. A bank run will kill any bank, regardless of their loan profile. To date, its been fear of future credit losses that have caused liquidity issues, not actual credit losses.

The whole premise of the western banking system over the last century or so is that bank runs are rare (e.g. 150 years since the last one in the UK pre-Northern Rock) and that either

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Originally Posted by geysir

the bank collapses or someone (like the government) steps in to prop up the bank.

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Obviously the events of the last year have caused the whole area of liquidity risk management to be completely re-defined and its likely, that when the dust settles, a more quantitative approach to liquidity management will emerge. But its too early for that to be realistically be expected at this stage.

Having not understood any of that, can someone tell me whether the losses the banks are likely to make over the next few years will be greater or less than the profits they've accumulated over the last few years? That is, were they gambling their own money or depositors money?

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Originally Posted by Bald Student

Having not understood any of that, can someone tell me whether the losses the banks are likely to make over the next few years will be greater or less than the profits they've accumulated over the last few years? That is, were they gambling their own money or depositors money?

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Depends how much depositers money is left in the bank and what the credit losses are!

If you take the extreme example and assume every loan a bank has extended isn't repaid, then yes, this won't cover savings. Obviously this example is as extreme as to be irrelevant, but then we just get into arguing about the future level of credit losses and deposit gains and losses.

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Originally Posted by OneRedArmy

Depends how much depositers money is left in the bank and what the credit losses are!

If you take the extreme example and assume every loan a bank has extended isn't repaid, then yes, this won't cover savings. Obviously this example is as extreme as to be irrelevant, but then we just get into arguing about the future level of credit losses and deposit gains and losses.

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Why would it depend on how much depositors money is left in the bank?

If I may ask a simpler question then, do we know what the accumulated profits of the banks are?

Iceland Interest Rate increased to 18% today. Inflation running at 15% apparently. :eek:

Need to put in a foot..ie change request for detailed financial jargon filter :p

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Originally Posted by Bald Student

Why would it depend on how much depositors money is left in the bank?

If I may ask a simpler question then, do we know what the accumulated profits of the banks are?

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Remember that banks have historically paid out a sizeable percentage of their profits immediately as dividends to shareholders so they don't carry huge retained profits year on year.

Therefore the retained profits, along with the rest of the capital base, is nowhere near enough to pay back all deposits, credit losses or no credit losses. This isn't just an Irish issue, banks, in general, cannot repay all depositors if they all land on the doorstep at any given time. This is liquidity risk (the fact that there is a maturity mismatch between a banks assets [loans] and its liabilities [deposits]). You phrased it in the "are they gambling the depositors money" way. The broad answer to this is yes, thats what banking is all about. Banks earn a risk premia (profit) as depositors demand a certainty over the security of their deposits, whilst their is an inherent risk of non-repayment in each and every loan a lender writes. Thats credit risk. How banks fund and leverage their loan book impacts their liquidity as the more assets they hold in cash or liquid instruments reduces the amount they can loan out for better return.

So banking by its nature is a large balancing act, that is firmly based on past experience as a guide to the future. And just like the ad says, sometime past performance is no guarantee of future return, and in this case it wasn't.

"one in one hundred" or "tail event" are words you'll hear very often in finance. They refer to the likelihood of a particular event occuring as being 1%, i.e. on average once a century.

This is important, as the closer you move to the tail (the unlikeliest of events) the more it costs to ensure the event doesn't happen, and on a marginal basis, the marginal cost increases hugely.

Therefore many banks over the last 3-5 years stressed their portfolios to cope with a 1 in 10,25 or even 1 in 50 event. What we are going through is widely acknowledged as a 1 in 100 event that very few banks (if any) would've planned for as the cost of protecting themselves against it would likely have been too onerous and uncompetitive to bear unless all banks globally were forced to do the same.

I'm trying to make this an uncomplicated as possible, obviously failing somewhat, but in some areas it isn't easy to explain. I've been working at it for coming up on 10 years and I'm still learning every day.

Would it be correct then to say that the banks will likely make a loss of more than their accumulated profits, requiring them to get money from somewhere, like the government, to make up the difference?

Also, do we know what those accumulated profits are?

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Originally Posted by Student Mullet

Would it be correct then to say that the banks will likely make a loss of more than their accumulated profits, requiring them to get money from somewhere, like the government, to make up the difference?

Also, do we know what those accumulated profits are?

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What will force a capital injection (probably underwritten by Govt) is for losses to reduce the capital ratio to an unacceptably low level. Very broadly, capital is made up of shareholders equity & cash-type instruments.

As stated above, accumulated profits are an irrelevance when they have been paid out to shareholders they can't be returned.

Have a look at the annual report of any of the large banks on their websites for more info on the composition of balance sheet & the annual P&L.

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Originally Posted by OneRedArmy

Very broadly, capital is made up of shareholders equity & cash-type instruments.

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Thanks, I think that's the point that had me confused. Is it correct then to say that capital includes money that the bank has on deposit?

In my simplistic model of the situation I've divided the money in the bank into two categories. The first is money that belongs to the bank like accumulated profits (minus whatever they've given back to shareholders) and the second is money that the bank is minding for someone else like peoples deposits or a loan from another bank.

The point of my questioning is to find out whether the losses that they're likely to make is greater than the amount of their money that belongs to them because if it is they'll have to dip into the second pool to make up the difference.

Unless I'm misunderstanding you, you're using the word 'capital' to describe a mix of both types of money.

Quote:

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Originally Posted by OneRedArmy

Therefore many banks over the last 3-5 years stressed their portfolios to cope with a 1 in 10,25 or even 1 in 50 event. What we are going through is widely acknowledged as a 1 in 100 event that very few banks (if any) would've planned for as the cost of protecting themselves against it would likely have been too onerous and uncompetitive to bear unless all banks globally were forced to do the same.

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in engineering we call that storm events, and the recent meteorlogical problems in ireland with floods and what not give you an indication of how good are preparations against these events are.